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Defining Inflation

Inflation is a steady rise in prices, owing to which, incomes and savings of the population will depreciate. Even the weakest inflation is dangerous for the development of the modern monetary economy. Therefore, all countries (including the most developed ones), take anti-inflationary measures to reduce inflation rates.

What causes?

Inflation – a monetary phenomenon associated with issuance of excessive money for circulation compared with the supply of goods. This increase in money occurs for various reasons. And the first of them is the growth of incomes of the population, not supported by a corresponding increase in the production of goods. This excessive demand pushes up prices and increases inflation rate. This imbalance between supply and demand for goods and services can also be resulted by crop failures, import restrictions, or actions of the monopolists. Also, rising costs of the production and increasing expenses of enterprises for wages, taxes, interest payments and others highly contributes to increase of inflation rates. Furthermore, the increase in prices for imported components shows both an increase in world prices and weakening of the national currency. The weakened national currency can directly affect the prices of the final products imported from abroad. The overall effect of exchange rate changes on price dynamics is called the “transfer effect” and is often viewed as a separate inflation factor. An essential role in the development of the inflationary process is played by the so-called waiting moments. The expected rise in prices forces the population to buy goods. Thus, a deficit is created for some of them, and, consequently, prices are rising. It is difficult to bring down such inflationary expectations.

Inflation can take many forms. In a regulated economy (such existed in the USSR), as well as in wartime conditions, when prices are fixed, it can have a hidden character – this is so-called suppressed inflation. It is followed by the deficit of many products, a surge in shadow trade, a sharp increase in prices in the markets, etc. However, the repudiation of such regulation (after the war or in countries that have passed from an administratively regulated to a market economy) often generates “galloping inflation” with a frenzied price increase. It arises from the discrepancy between the supply of money and the insufficient quantity of goods. The other forms of inflation include:

– Unforeseen inflation – the rate of inflation which has appeared above expected for a certain period;

– Expected inflation – the estimated rate of inflation in future period owing to action of factors of the current period;

– Open inflation – inflation due to increase in prices of consumer goods and production resources;

Negative Consequences of High Inflation

High inflation rate decreases purchasing power of all economic entities which negatively affects demand, the economic growth, the standards of living of the population, and moods in society. Depreciation of the income narrows opportunities and undermines incentives to saving that interferes with formation of a steady financial basis for investment. Besides, high inflation is accompanied by the increased uncertainty which complicates decision-making of economic entities. Overall inflation negatively influences savings, consumption, production, investments and general conditions for sustainable development of economy.

How to decrease?

Fighting inflation, as the experience of developed countries shows, is extremely difficult. It seems easy: freezing prices or introduce some form of regulation for prices. Unfortunately, this method is effective for a short time only. The freezing of prices will soon be triggered by an increase in the deficit of goods and will further exacerbate inflation. The other method of fighting inflation is through contractionary monetary policy. The aim of this policy is to reduce the money supply within an economy by increasing interest rates. This helps to reduce spending because those who have money want to keep it and save it, instead of spending it. It also means less available credit, which also reduces spending.